Monetary Policy Stance & Limitations

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 Monetary Policy Stance

1. Hawkish
(High Interest rate – Control Money supply)
  • Resembling a hawk in nature or appearance.
  • The central bank of a country (RBI) wants to guard against excessive inflation.
  • Meaning in Economic Terms – In order to keep inflation in check, the Hawkish stance favours high-interest rates. Because of the high interest rates, borrowing (taking loans from banks) will become less attractive.
  • So, understand that whenever RBI says that the Monetary Policy Stance is Hawkish, it means there would be a rate hike.
2. Dovish
(Cheap money policy - Smooth & Expansion of economy)
  • It can be said more or less the opposite of Hawkish. It is a calmer approach as compared to Hawkish. This stance is taken when the economy is not growing and the government wants to guard against deflation (decrease in the cost of goods and services). There is a need to stimulate the economy.
  • Meaning in Economic Terms – This monetary policy stance involves low interest rates. Low-Interest Rates would entice consumers to take credit (loans) from Banks and other sources. It is rate cut
  • Now that people have money in their hands or let’s say money at their disposal, they would start spending more and thereby demand the products and services would rise.
3. Accommodative
  • Meaning in Economic Terms – This happens when a central bank (RBI) attempts to expand the overall money supply to boost the economy when the economic growth is slowing down. The major aim is to increase spending.
  • Accommodative monetary policy is implemented to allow the money supply to rise in line with national income and the demand for money. This is also known as “easy monetary policy”.
  • When the economy slows down, the central bank (RBI) can implement an Accommodative Monetary Policy to stimulate the economy. It does this by running a succession of decreases in the Interest rates, making the cost of borrowing cheaper. Accommodative money policy is triggered to encourage more spending from consumers and businesses by making money less expensive to borrow through the lowering of short-term interest rates.
4. Neutral
  • The policy rates neither stimulates (speed up) nor restrains (slowdown) the economic growth by taxation and government spending. Economic conditions are just right. The Key Policy Rates are neither increased nor decreased.
Limitations of Monetary Policy
  1. Limited role in Controlling prices – Cost push Inflation – Food & Fuel is out of MPC control & needs administrative measures
  2. Existence of Black Money – Which is out of formal Money supply net
  3. Large non- monetized and Informal sector
  4. Large number of NBFCs
  5. Conflicting objectives of various sections
  6. Underdeveloped money market
  7. Complex economic conditions make is challenging for MPC to accommodate divergent needs
  8. Liquidity Trap
Liquidity Trap
(Reduce interest rate to boost liquidity in economy – but people not spend, start saving the money).
  • Liquidity trap is a situation when expansionary monetary policy (increase in money supply) does not increase the interest rate, income and hence does not stimulate economic growth.
  • Description: Liquidity trap is the extreme effect of monetary policy. It is a situation in which the general public is prepared to hold on to whatever amount of money is supplied, at a given rate of interest.
  • In that case, a monetary policy carried out through open market operations has no effect on either the interest rate, or the level of income. In a liquidity trap, the monetary policy is powerless to affect the interest rate.

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